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Why existing home sales drop as affordability declines

Brent Nyitray, CFA, MBA

Existing home sales drop to 5.12 million in October

The National Association of Realtors (or NAR) reports existing home sales once a month. The seasonally adjusted number reports completed transactions in single-family homes, condominiums, townhomes, and co-ops. The report includes such data points as existing home sales, inventory of houses for sale, median house price, mortgage rates, and median time on the market. Sales are well approaching April levels, which shows that the increase in rates since May 1 is finally starting to be felt. Increasing interest rates and higher prices mean declining affordability.

Restricted supply has been the theme of the U.S. housing market over the past year

At the end of October, there were 2.13 million existing homes for sale, representing a 5.0-month supply. As professional investors have become major players in the real estate market, we’re seeing bidding wars for properties in the hardest-hit markets, like Phoenix, and even strong markets, like Washington, DC. For all the fears that a flood of properties would hit the market and drive down prices, the opposite problem has happened. That said, NAR forecasts that the jump in rates will begin to affect affordability in high-cost areas like California and the New York City metropolitan area.

Prices continue to rise

The median sale price for an existing home was $199,500, which is up 12.8% year-over-year. The housing inventory supply of 5.0 months signals a market tilted more towards sellers. A six-month inventory typically means balance. Last year at this time, there were approximately 5.2 months worth of supply. There’s definitely more demand than supply in the market, and some hot markets, like San Francisco and Phoenix, are experiencing the bidding wars we used to see in 2006. This increase in median home prices is somewhat overstated in that most of the transactions are concentrated in a few areas. Nationwide, we’re not seeing such large increases in prices.

Homebuilder earnings were generally strong

Second quarter earnings for the builders were generally strong, but we began to see some cracks in the foundation for the first-time homebuyer. KB Home (KBH) and Lennar (LEN), reported decreases in traffic, particularly at the lower price points. NVR Homes (NVR) recently reported better-than-expected earnings, but the Street was put off by its 19% cancellation rate—the highest since 2008. We should hear from PulteGroup (PHM), another builder that concentrates on the first-time homebuyer, soon. Standard Pacific (SPF) reported good numbers as well.

First-time homebuyers accounted for 28% of all sales—well below their historical level of 40%. The first-time homebuyer has been absent due to tough credit conditions, heavy student loan debt, and a difficult labor market. As those circumstances change, a lot of pent-up demand will release, which should drive homebuilder earnings for quite some time. Also, restricted supply has been a major feature of the current housing market. If there’s a shortage of existing properties for sale, buyers will naturally turn to new construction.

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